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Peter A.G. van Bergeijk discusses this topic and it’s implications on policy makers.

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G.M. Peter Swann analyses econometric illusion

G.M. Peter Swann, Emeritus Professor of Industrial Economics Nottingham University Business School

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G.M. Peter Swann, Emeritus Professor of Industrial Economics Nottingham University Business School

I believe that the operation of an economy is a good model for the operation of an academic discipline like economics. A well-functioning economy is one where there is healthy competition, we trade with other economies, and pursue innovations that improve the performance of the economy and create wealth. In the same way, a well-functioning discipline should also have healthy competition, trade with other disciplines and pursue innovations that improve the performance of the discipline and create knowledge.

Is this what we find in the economics discipline? Up to a point, yes. There is some competition, trade and innovation in the discipline, but I would say that it is much more limited than what we would find in a healthy economy.

This short piece focuses on innovation. The first important lesson we learn from studying innovation in the economy is that there is an essential distinction between incremental innovation and radical innovation. The use of the adjective incremental need not mean that the innovations are small. It means that they involve successive improvements in achieving a specific objective, where each innovation builds on all that has gone before. And the use of the adjective radical need not mean that the innovations involve ‘rocket science’, nor that they are controversial, but it does mean that they involve going back to the ‘roots’, and doing some things in a different way. If the process of innovation is to fulfil its full economic potential we need both types of innovation. Neither is sufficient without the other.

The second important lesson is that incremental and radical innovations tend to emerge from rather different environments. The best environment for incremental innovation is one in which there is an enduring division of labour. This is often an organisation with a reasonably stable organisational structure, where job descriptions and work routines are narrowly defined and stable over time. Staff build up a detailed knowledge of their part of the production process over a long period, and so they are exceptionally well qualified to point out ways in which it could be improved. Moreover, in such an organisation, staff in one specialised division often have little or no horizontal communication with other divisions, for the simple reason that it would serve no purpose. In such an environment, staff are encouraged to think inside the box.

In contrast, the best environment for radical innovation is one where staff are encouraged to bring together disparate and dissimilar knowledge. This is an organisation that wants some employees, at least, to think ‘outside the box’, because thinking outside the box is the best route to radical innovation. One type that is often discussed in this context, is the relatively young company, that has not yet developed a rigid organisational structure, where job descriptions are not ‘set in stone’, and where work routines are not stable over time. In such a ‘melting pot’, variability in working patterns means that workers are constantly being assigned to different groups, where they interact with people of different experience. In such an environment, staff are encouraged to think outside the box, and they are empowered to do so because they have accumulated considerable experience of problem-solving in teams with people of different experience and with diverse knowledge bases.

Mainstream economics is good at incremental innovation because it resembles the first type of organisation described above. But it is bad at radical innovation because it does not remotely resemble the second type of organisation described above. Indeed, mainstream economics clearly feels uncomfortable with most radical innovation.

In an innovative sector of the economy, it is commonplace to find an industrial structure that includes both types of organisations. There are the well-established and large incumbent firms who offer mainstream products and services, and incremental innovations. There is also a fringe of newer and innovative firms who aim to improve on some of the offerings from the mainstream, and offer something radically different. This is entirely healthy. In the same way, I think it is entirely healthy to create a similar ‘industrial structure’ in the economics discipline, and a similar fringe where radical innovations can flourish. That is radical, in the sense that it means going back to the roots and doing some things in a different way, but I don’t think it is controversial.

How do we create such an industrial structure? We should follow the example of many other disciplines, and change the constitution of the economics discipline from the conservative unitary state that it is at present, into a federation of semi-autonomous sub-disciplines. The following disciplines have all gone down that route: medicine, physics, chemistry, neuroscience, materials science, cognitive science, computing, geography, history, and business studies. Economics has sub-disciplines, certainly, but they enjoy little or no autonomy. Semi-autonomy is essential because radical innovation entails doing things that the mainstream may not approve of, but which are essential to solve the problems facing the discipline as a whole. These necessary innovations will only flourish in a federation where each sub-discipline has sufficient autonomy.

What new things will we find in the federation? If we are to give economics a proper empirical foundation, rather than rely on the black-box foundations built by econometrics, then we need to emulate the three essential empirical foundations of medical science: anatomy, physiology and pathology. Economic anatomy and economic pathology are still hopelessly under-developed. Economic physiology is quite well developed, but it is a black-box science, and does not draw on a deep understanding of economic anatomy.

There will also be a variety of hybrid disciplines in this economic federation – just as there are in medicine. These will include hybrid disciplines formed from several academic discipline – for example, in my own field of innovation. There will also be hybrid disciplines formed by academic economists working together with a wide variety of practitioners. These hybrid disciplines can play an essential part in addressing many sources of discontent amongst those outside the economics discipline.

This is how the economy creates the necessary mix of incremental and radical innovations.

I believe that it would be a very good idea if the economics discipline were to become more like the economy.

G.M.P Swann, Economics as Anatomy: Radical Innovation in Empirical Economics, Cheltenham: Edward Elgar Publishing (2019)

Peter A.G. van Bergeijk and Selwyn Moons look at and analyse the importance of economic diplomacy.

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